Dell LBO objectors in tight corner

By Robert Cyran and Richard BealesThe authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Objectors to the founder’s $24.4 billion leveraged buyout of Dell are in a tight corner. The likes of Southeastern Asset Management are right that Michael Dell and Silver Lake Partners have made a lowball offer. Yet it’s at a respectable 25 percent premium, and the company’s shares haven’t topped the $13.65 per share deal price in months or Southeastern’s $23.72 per share valuation in years.

Dell’s net cash, its finance business at book value and the cost of recent acquisitions, which Dell says are doing well, add up to almost $13 a share, as Southeastern points out. That’s practically the whole of the LBO price, yet it ignores the value of Dell’s server and PC business and most of its IT consulting. Those businesses may be in decline, but they are not worthless.

Or look at it this way. Analysts expect Dell to generate $4.6 billion of EBITDA in the coming year. After capital expenditure, estimated interest costs following the buyout and taxes, the company will probably churn out more than $2 billion in free cash flow. That’s an impressive return on the buyers’ roughly $6 billion of equity – much more than sufficient to compensate for the risk of a continued slide in the PC business.

Southeastern is justified in worrying that the role of the founder and largest shareholder will deter rival bids, despite the board’s efforts to use independent advisers and allow a period to find a buyer at a higher price. Industry rivals might want to pick off some Dell units, but most likely not the whole. And without Michael Dell’s willing involvement, it is probably too big a bite for private equity funds. Moreover, short-term investors betting on the sale – who perhaps now hold a quarter of all Dell’s shares – will mostly vote for the bird in hand if the alternative is the stock returning to earth with a thud.

Southeastern’s other ideas require patience. For instance, a big special dividend financed by debt would still leave shareholders with a period of high leverage and potential earnings volatility before they have as much in their pockets as the buyout price. Yet returning about $4 billion to investors over the past two years via buybacks and a recent dividend has not done anything to persuade public investors of Dell’s charms.

Investors have had time to understand Michael Dell’s turnaround plan, but Dell’s shares traded at no more than about $11 apiece in the months before buyout rumors surfaced in early January. Not enough shareholders seem to be persuaded it’s worth waiting around. More optimistic owners like Southeastern, with its 8.5 percent stake, could be in a position to force the price higher. But barring a major surprise, it looks as though alternatives to the LBO provide too little certainty to match up.